This is a collated assortment of hints and tips for contractors. It's primarily contributed to by UK based IT contractors so may not be directly applicable outside of that area, especially where tax and legal procedures are discussed.
Disclaimer: Whilst this document contains some broad discussions around tax and financial issues, it is definitely not offered up as financial or legal advice in any way. Please consult a qualified specialist for advice tailored to your specific situation!
- Getting Started
- Your First Contract
- Tax Responsibilities
- Withdrawing Money From your Limited Company
- Mortgages
If you're considering becoming a contractor but aren't quite sure what's involved or when to make the leap then this section might help.
Common questions that budding contractors will ask themselves and others is "When should I start contracting?", "How much experience should I have before starting contracting?", "How much of a savings pot should I have before contracting?", and similar.
Alas, the answer to most of those is "It depends!", and is based on a variety of factors.
In general, contracting opportunities are aimed at mid-level to senior/lead positions. At one extreme, some have been known to start their careers as a contractor. At the other, some have waited until they have 10+ years of permanent experience under their belt before going for their first contract role. ust as with taking a leap to a new permanent role, your confidence in your own abilities and experience should be used to determine whether you think you will succeed in a contract role.
In terms of your financial position, again this will be very much up to your inidividual risk appetite and existing financial commitments. Some contractors have been fortunate enough to leave their permanent position and start their first contract immediately, much like moving from one permanent role to another. At that point, the risk comes down to how likely one feels their contract will be terminated prior to them being able to save a sufficient 'buffer' in their business account for when lean times hit. Conversely, some contractors wait until they have sufficient personal savings behind them so that they can comfortably leave their permanent position before starting to look for contract work.
Whilst the above may sound very vague, it is necessarily so because so many factors depend on your personal situation. However, there are a couple of key take away points:
- Ensure you are confident in your abilities and experience to deliver what the role requires. This isn't dissimilar to what you would with a permanent position. Remember - a 'permanent' role is only as permanent as the notice period in the contract; a 'contract' role can usually be terminated within 2 weeks. The role itself will require the same level of skills, experience and professionalism whether it's being performed by a permanent employee or a contractor
- For financial security, we'd suggest either:
- Have sufficient savings to cover 6 months of your usual outgoings in case your hunt for that 1st contract role takes longer than you expect, or it is unfortunately terminated early.
- If you're fortunate enough to land a contract role whilst still in permanent employment, save hard during that initial contract to build up a buffer such that you can continue to draw sufficient monies from your business account for a while if/when you do end up between contracts. It's also important to note that a lot of the money you will receive into your business bank account will need to be paid out in various taxes (more on those later). For now, you need to remember to factor those taxes in when assessing how much money constitutes a safe buffer.
So, congratulations, you've decided to become a contractor! Our first concrete recommendation is to get an accountant.
An accountant will help with a number of very important things during your contracting career:
- Forming your company
- Filing various tax returns with HMRC on your behalf
- Running your monthly payroll
- Calculating the most tax-efficient mechanisms for withdrawing monies from your company based on your own personal circumstances
- Offering advice, and answering questions, on any of the above
Whilst there are many accountants out there, and we obviously can't tell you which one is right for you, here are some guidelines based on our experiences:
- Make sure that they use FreeAgent for tracking your accounts. Whilst the various contributors might disagree on which OS or IDE is best, we're all in agreement that FreeAgent is a must have for helping you keep track of your accounts, invoices, tax liabilities, etc.
- If your accountant of choice isn't using FreeAgent, the onus will be on you to keep it up to date with their records which can be time consuming depending on the complexity of your accounts. In addition, you (through a business expense) will have to foot the bill for using FreeAgent yourself, whereas some accountants that use it will include that cost in your payments to them
- FreeAgent has a list of accountants that use their software; an important note though is that you don't need to use one in your local area if you're comfortable with online and over-the-phone support only
- Maslins come highly recommended from those of us that have used them
- You may have friends, family, or friends-of-the-family that are qualified accountants, and that personal touch might be important to you. It's important to note that whilst they will necessarily know a lot about both your business' and your personal financial position, they are professionals, so won't disclose this information to others.
You can do this yourself via the government portal or you can engage your accountant to form your company for you. Many will do this for you for a one time fee in the region of £100.
If you are full time contracting through a limited company then the odds are your company will surpass the threshold requiring your to register for VAT.
You can do this yourself via the government portal or you can engage your accountant to do this for you. This is often done at the same time they register your company for you.
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When looking at contracting roles, they will usually (but certainly not always!) specify whether or not they are classed as "inside" or "outside" of IR35 for tax purposes. If the contract role you are considering doesn't stipulate its IR35 status, make sure this is the first clarification question you ask, because it will make a massive difference to the money you receive from your client!
IR35 was designed to catch people who operate a limited company in order to evade their Income Tax liabilities; by operating as a 'disguised employee', they were treated no differently to actual permanent employees in terms of levels of management control, etc. but could enjoy the tax benefits of setting their own (low) salary.
If a contract is deemed as inside IR35, that means that the client believes that, because of the terms and conditions of the contract, you are indistinguishable from a regular employee for tax purposes. It is, therefore, the client's responsiblity to ensure that the correct Income Tax and National Insurance contributions are paid. Although arrangements for this differ, it's quite common for clients to engage with an Umbrella Company to handle this for them. Under this arrangement, you're considered an employee of the umbrella company; you get a salary from them from which you will be deducted Income Tax and National Insurance contributions at the normal rates.
If a contract is deemed as outside IR35, that means that the client believes that the engagement is much more akin to one that they might have with any other supplier such as IBM, Microsoft or Infosys; they have asked for a particular service or consultancy outcome to be delivered and have no/little control over the exact nature of how that delivery occurs. For example, you may have signed the contract as the director of your limited company, but under the right of substituion, you are under no obligation to personally deliver the services.
Note that the IR35 status of a contract has implications for what taxes are your limited company's responsibility to pay. Relevant sections below are prefixed with an Inside-IR35 note.
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Running your own Limited Company brings with it some tax responsibilities that you will have been somewhat insulated from as a permanent employee. These can seem quite daunting at first, especially given the different frequencies with which they are paid. Please note, again, this section offeres general guidance only; it in know way constitutes any kind of financial or legal advice!
Inside-IR35: This section doesn't apply to Inside-IR35 contracts arranged through an umbrella company; VAT is the umbrella company's responsibility.
VAT is added to your invoices automatically at the Standard Rate (currently 20%).
For a simple worked example, let's assume a 20 working-day month at a day rate of £500. That means we would charge our client 20 * 500 = £10,000, then an additional £2,000 for VAT bringing the total to £12,000.
In the simplest, and we would argue, the majority of cases for contractors, you would therefore pay HMRC the £2,000 VAT you received. One potentially useful way of thinking about this is that you're simply acting as a tax collector/proxy for HMRC.
There are instances where you can reduce your VAT bill, e.g. by paying for IT equipment. We would suggest that you should check with your accountant, at least the first few times you make such purchases to ensure that they are marked with the correct VAT. This will mean that FreeAgent will make the necessary adjustments such that you can file the correct returns to with HMRC.
VAT returns and payment are usually due once per quarter. The exact dates will depend on your company's accounting period but will be available in your online HMRC account and, of course, FreeAgent.
Inside-IR35: This section doesn't apply to Inside-IR35 contracts arranged through an umbrella company; PAYE & NI contributions are the umbrella company's responsibility.
Just as with a permanent role, you will in all likelihood draw a salary from your business. That salary is subject to income tax and National Insurance deductions. Your accountant will set your payroll up in FreeAgent though, which makes this trivial to calculate, submit Real Time Earnings returns for, and ultimately pay.
Your accountant will be able to advise a reasonable salary for you to draw based on your tax code, and will help adjust this each year as tax allowances change. The Contractor Income Calculator can also be used to give you a reasonable starting point for discussions with your accountant.
Our general experience is that contractors always try to draw at least enough salary to trigger National Insurance payments in order to ensure full state pension contributions.
Inside-IR35: This section doesn't apply to Inside-IR35 contracts arranged through an umbrella company; Corporation Tax is the umbrella company's responsibility.
Corporation Tax is a tax on the profits that your limited company makes in a given financial year. It is currently set at 19% and is payable 9 months and 1 day after the end of your company's accounting period (e.g. if your accounting period ends on 5th April 2021 your Corporation Tax will become due on 6th January 2022).
Unfortunately, as a contractor, you are unlikely to incur many allowable business expenses that will significantly reduce this tax burden. Our experience has shown that contributing to a pension is the most efficient way of doing so, but please speak to an accountant or tax advisor to ensure that is the case for you and your specific circumstances.
Inside-IR35: This section does apply to Inside-IR35 contracts arranged through an umbrella company, on the assumption that you continue to operate a limited company. You can expect a vastly reduced (or even nil) Self Assessment tax liability though.
As a director of your limited company you will have to register for Self Assessment Income Tax. This will enable HMRC to collect tax from any additional income you may have, such as dividends.
This is, arguably, the most complex tax to understand in terms of payment amounts and deadlines. From HMRC's own guidance you will need to pay your first Self Assessment at the end of the January following the end of the tax year just gone. e.g. if the tax year ends on 5th April 2021 you will need to pay by 31st January 2022. However, in most circumstances you will need to make a 2nd payment on account by 31st July of that same year to go towards 2023's Self Assessment tax bill!
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There is the perception amongst high street lenders that contractors are more risky to lend to so approaching a bank directly will almost always end in a no.
You can get mortgages with very little/no prior contracting provided you have been in the industry a while and have a good day rate (One person obtained a mortgage 2 months into their first 3 month contract with nothing lined up for after!)
There are a number of specialist mortgage brokers who can help to arrange mortgages for contractors and in some cases obtain better deals than available at high street banks.
Contractors have had successes with the following brokers:
Its usually worth asking people for referrals as often there are incentives (we all love free money)